iFund-Is Phillips Curve dead?

2019-07-11 09:49
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The current Fed Chairman Powell, who recently attended the congressional hearing, also agreed that the current unemployment rate and inflation relationship have become less relevant.

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The Phillips Curve was proposed in 1958 by William Phillips, a New Keynesian economist and a professor at the London School of Economics. The theory argues that as the economy grows, more jobs opportunities and lower unemployment rates lead to higher inflation. Conversely, rising unemployment leads to lower inflation. Therefore, there is an inverse relationship between inflation and unemployment.

However, due to the stagflation in the 1970s, i.e. high inflation and high unemployment, the economists questioned the effectiveness of Phillips curve. This question has reappeared after the Global Financial Crisis of 2007-2008, but due to a different reason: a extremely low unemployment rate (close to the lowest level in 50 years) with slow wage growth and inflation lower than the 2% target of the Fed.

Powell said unemployment and inflation have become less relevant

In fact, former Federal Reserve Vice Chairman Alan Blinder wrote “Is the Phillips Curve Dead? And Other Questions for the Fed” in the Wall Street Journal last year, saying that when in the 1990s, if unemployment rose by 1 percentage point for a year, inflation rate would drop half a percentage point. However, since 2000, the correlation between the two has been close to zero. The current Fed Chairman Powell, who recently attended the congressional hearing, also agreed that the current unemployment rate and inflation relationship have become less relevant.

According to the latest CME FedWatch Tool, the chance of interest rate cuts in July are still 100%. the chances of rate cut by 25 bps or 50 bps are 67.2% and 32.8% respectively. By the end of December this year, the chances of rate cut by 50 bps and 75 bps are 32% and 37.6%. This implies market expects Fed gives 2 to 3 rates cut by the end of this year.

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